Introduction Crypto investments are rapidly gaining popularity for their vast array of financial solutions, including decentralised finance (DeFi). Decentralised Finance or DeFi are financial services set up using blockchain technology. DeFi uses blockchain technology which eliminates the need for intermediaries and traditional financial institutions like banks. The core concept of DeFi is to make financial […] The post Risks And Rewards Of DeFi appeared first on ZebPay | Buy Bitcoin & Crypto.
Crypto investments are rapidly gaining popularity for their vast array of financial solutions, including decentralised finance (DeFi). Decentralised Finance or DeFi are financial services set up using blockchain technology. DeFi uses blockchain technology which eliminates the need for intermediaries and traditional financial institutions like banks. The core concept of DeFi is to make financial instruments more accessible for all while offering complete transparency.
Rewards offered by DeFi
Unlike traditional finance, DeFi does not require a wide array of conditions to be met before processing transactions. Smart contracts that are in place generate efficient lending, borrowing, and investing.
For example, most of the time, Crypto lending transactions only require a small amount of capital. The user will not have to wait for multiple credit checks before accepting the crypto loans.
DeFi transactions are highly flexible in terms of usability, where loans can be squared off, and transactions can be completed seamlessly, without any hassle of more documentation. Multiple types of automated financial transactions can be explored through the DeFi system.
Example: A single blockchain like Ethereum can support DeFi apps to carry out deposit-based transactions or even complex swaps seamlessly, all under the same roof.
Smart contracts make transactions on the blockchain irreversible and highly secure. From the collateral needed for lending to the liquidity pools, the intelligent contract terms are what determine how to secure crypto investments can be. The highly automated systems also limit human interference, which is a barrier to controlling illicit activities.
DeFi makes finance equal for all. Without generalising between users, DeFi’s accessibility does not rely on factors like age, credit scores, occupation, and other personal details that users may not be comfortable sharing. Anyone can become a lender or join a liquidity pool, and anyone can borrow funds or make internet-earning deposits.
As a result of the automation, transactions on DeFi happen extremely fast. Once a condition on the smart contract is met, the following action is quickly processed, furthering or completing the transaction. Eliminating interference from a third party also makes the transactions rapid.
Examples: If an insurance claim were to be made on DeFi, the smart contract would have specific conditions to be met. Once the conditions are met, like insurance claim reports, proof of damage, etc., the transaction is automatically set in motion.
Risks of DeFi
The crypto market is highly volatile, which impacts DeFi as well. While lending may be straightforward, the market’s volatility may not always aid investors in recovering the money and paying off the loan. Sometimes, the crypto market crashes, forcing investors to liquidate and lose their investment.
DeFi does not follow most of the regulatory obligations put in place by many countries after years of encountering fraud. Experts sometimes question the credibility and legality of crypto itself. This poses an imminent risk to blockchain and crypto-driven DeFi apps and their future viability.
At-risk Smart Contracts
While no code could be entirely full-proof, most smart contracts are open source which means any attempts to hack into them can be trounced. However, attacks on crypto investments, despite intelligent contracts, are not entirely unheard of. Reading the details of the smart contract is necessary before entering a transaction, and it is always recommended to enter a crypto transaction from trustworthy, verified sources.
The consequences of a volatile market could result in an imbalanced market and a mismatch between the demand and supply in liquidity pools. This causes a drop in the value of investments within the liquidity pool. Compared to holding assets, investing in liquidity pools carry the additional risk of impermanent loss.
DeFi rug plugs
Under the pretext of high yields, developers often collect deposits from investors only to escape with the deposits in an enormous exit scam. These developers often try to get linked to popular existing cryptos to gain trust. However, the intent to exploit is often hidden in the fine lines of the smart contract through which they pull this off. Therefore, it becomes crucial for investors to understand the risks involved before making any investment.
Risks and rewards go hand-in-hand for most transactions, be it traditional finance or blockchain. Weighing the pros and cons and creating a strategy that suits the investors’ risk appetite becomes imperative to making the most of crypto investments. Stay tuned to ZebPay to learn more about DeFi risks and rewards and how to mitigate the risks involved.